Hi Ted

Prop trading simply means taking a directional (non-hedging) position in the market.

Sometimes people think it ONLY means you work for a prop firm i.e. a firm (bank or trading company) that trade with a direct view on a particular market.

I trade from home and take prop positions on different markets eg. gold/oil/es. I trade with my own capital.

A trader working on a bank prop desk will also take prop (directional) trades on the market. However he is using the banks funds and not his own. This differs from other bank traders such as market makers whose job is to quote prices on markets all day long.

Hope that makes sense.

Anything that says CME is typically futures. Essentially, prop firms who do large volumes have an exchange membership that allows them to have lower exchange fees for their members. In order to extend these privileges to their members who may bring their own capital, they are required to have a membership.
The prop firms that extend these privileges typically look for real-time track records, because they must by law also participate in the customer's losses. I do not know any firm with a structure above that take traders with hypothetical results. This is the biggest myth about prop trading.

Thanks,
Matt Z
Optimus Futures

There is a substantial risk of loss in futures trading. Past performance is not indicative of future results.

Hi ProUK Trader,

Thanks for your fast reply n help here but I don't think I understand much. I don't know the major differences between directional position and hedging position. What I know simply is that directional positioning has to do with options trading and hedging is more for the risk control of a commodity, on the prevention side, even tho both types do have contract expiration.

Directional trading examples:

1) I think ES futures are going up. I will buy ES Futures
2) I think volatility will go higher - I will buy options combinations eg straddles and strangles
3) I think volatility will go lower - i will sell options combinations
4) I think the 1 year vs 2 year oil spread will widen. I sell 1 year futures and buy 2 year futures

The above are all types of directional views on the market which could be on prices, volatility, yields, spreads etc. So its nothing to do with the TYPE of contract, but rather due to a directional view on a market.

Hedging strategies:

1) I am long 100 shares of Microsoft. I don't want to sell them but I want to reduce some risk, so can sell some call options with a higher strike price, or sell short a different tech company with very similar business like to Microsoft
2) I am long 6 month expiry ES options. A customer wants me to make a price for 8 Month expiry ES options. As I am long I could show a better offer (selling price) for 8 month options as this would reduce my volatility exposure.

NOTE: Hedging strategies are there to reduce overall risk, but they do not completely remove risk. This is because you are either buying or selling a similar, closely correlated product.

Thank you very much for your patience. These examples give me better understandings the nature about what a Prop Trading firm would possibly do even though I don't know much about options yet. It seems that directional trading is more profit oriented n hedging is more of risk management n portfolio balance.

These would lead to my next questions. Comparing a Prop Trading firm and a hedge fund investment, which one would do better? This question might be very generalized but please shed some light for me.

Have a great Sunday.

Prop traders typically do not take outside money but trade their own capital. Prop trading can refer to a few structures:

1.
What: Market makers, HFT Firms. These are the top tier.
How: Market making, spread trading, other alpha, typically trading many products but some may specialize in underlying they hold
Why: Superior rates, firm capital, infrastructure

2.
What: Stock trading prop firms
How: Special structure
Why: Get around PDT, rates, capital, collaboration (i.e. trading on a floor)


3.
What: Hybrid pay models. Tryouts, educational fees, etc.
How: Pass the requirements, discretionary, directional,
Why: capital, contracts, collaboration, ability to trade discretionary or other risk strategies that top tier firms might not trade

Regarding prop firms vs. hedge funds
Prop traders seek higher returns but accept greater risk in exchange and strategies may not scale as well. Investors in hedge funds will not accept the same degree of risk or p&l swings. A hedge fund investor wants a very high probability of at least making a break even or small return even at the cost of a lower net return. A prop trader must make a higher return because they are trading less capital.

For futures props, the main thing that I look at is the "scale up". Some of the tryout models do not offer a meaningful scale up. So, these firms are more about traders who want to try it out with limited risk. But a serious prop should have ability to scale you up to some significant level.